TY - JOUR
T1 - Partial index tracking enhanced mean–variance portfolio
AU - Cai, Zhaokun
AU - Cui, Zhenyu
AU - Simaan, Majeed
N1 - Publisher Copyright:
© 2024 John Wiley & Sons Ltd.
PY - 2024
Y1 - 2024
N2 - Estimation constitutes a major challenge in the implementation of mean–variance portfolios. To overcome this, we propose a partial index-tracking strategy that aims to mitigate estimation error ex-ante. Theoretically, we minimize the mean-squared error of the proposed strategy by shrinking the portfolio variance to its tracking error. Using an empirical design with over 50 years of data, our paper makes two important observations. First, we show that our proposed approach is consistent with both linear and non-linear shrinkage strategies in terms of robustness. Second, the proposed decision rule leads to a lower out-of-sample tracking error. Our findings, overall, stress the appeal of partial index tracking not only in terms of shrinkage (robustness) but also in terms of relative performance.
AB - Estimation constitutes a major challenge in the implementation of mean–variance portfolios. To overcome this, we propose a partial index-tracking strategy that aims to mitigate estimation error ex-ante. Theoretically, we minimize the mean-squared error of the proposed strategy by shrinking the portfolio variance to its tracking error. Using an empirical design with over 50 years of data, our paper makes two important observations. First, we show that our proposed approach is consistent with both linear and non-linear shrinkage strategies in terms of robustness. Second, the proposed decision rule leads to a lower out-of-sample tracking error. Our findings, overall, stress the appeal of partial index tracking not only in terms of shrinkage (robustness) but also in terms of relative performance.
KW - index tracking
KW - out-of-sample robustness
KW - parameter estimation risk
KW - portfolio optimization
UR - http://www.scopus.com/inward/record.url?scp=85188248511&partnerID=8YFLogxK
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U2 - 10.1002/ijfe.2967
DO - 10.1002/ijfe.2967
M3 - Article
AN - SCOPUS:85188248511
SN - 1076-9307
JO - International Journal of Finance and Economics
JF - International Journal of Finance and Economics
ER -